Are you biased?

Ok, Ok, I’m not being politically incorrect. I’m not asking about the bias we see discussed in the newspapers, on TV, or in the blogospheres. I’m talking about another kind of bias, the kind that creeps into your trading – trading biases.

The kind of bias you never know is there but yet lurks under the bed and in the closet like the green-eyed monsters used to. The kind of bias you never think about but has to be addressed by anyone who, not only develops systems but anyone who trades.

Are you biased? Ok, Ok, I’m not being politically incorrect

If you don’t recognize these biases, they will come out of the closet and could turn into your biggest nightmare.

When you are looking into trading with a new service, or any service, new or otherwise, you should be asking the developers about these biases. Check out if they acknowledge them and how they handle them.

Look-Ahead Bias

Backtesting results can be distorted with Look-Ahead Bias when trading decisions are based on information that is not yet available. This generally happens because extra data is accidentally included and we simply don’t realize it. These errors are often very slight, which is why they are so easily overlooked.

They can, however, have a dramatic impact on the overall results.

Here’s an example

Seriously, wouldn’t this be the system of all systems?

Only daily highs and lows available to you in your backtest data but you decide to build a system that bought at daily lows and sold at daily highs. Seriously, wouldn’t this be the system of all systems? It would be a machine for printing money. Problem is, in reality, you don’t know the daily high or low until the end of the day. Whereas when babacktesting you do know. Although this seems like a silly thing to do, let me assure you when you are in the midst of developing code, it is a very easy issue to overlook.

Here at QiT we have a process for developing new algorithms and one of the steps is to sniff out any kind of look-ahead biases.

Survivorship Bias

Survivorship Bias addresses the concept that many data providers do not include stocks that are no longer listed. The result is that the data set you are using for backtesting will only include the stocks that have survived to this point. This makes them skewed to the positive side because they do not include stocks that have not survived. Unfortunately, in the past, your system could have signaled these stocks and there is a good probability the trade was not profitable. If the stock was not in your data base then you did not include that trade.

Survivorship Bias addresses the concept that many data providers do not include stocks that are no longer listed

Here’s a scenario. You want to test how well your strategy does with the S&P 500 over the last 10 years. Would you not need a database that was able to identify which stocks were actually in the S&P 500 10 years ago? Would it be of any value if you tested only the stocks that were are in the S&P 500 today? I think not.

For more information on Survivorship Bias and why QiT is adamant about not using data with it click here.

Tolerance Bias

This is a different kind of bias and has nothing to do with coding but with your own trading so I decided to plunk it in here.

Every trader thinks that they will be able to withstand more drawdown than they will actually be able to tolerate.

Every trader thinks that they will be able to withstand more drawdown than they will actually be able to tolerate

Tolerance Bias is a trader overestimating his ability to tolerate drawdowns. This bias is completely psychological.

Let’s take an example. You’re looking at a strategy with 20% Max drawdown. You start trading and it immediately starts into a drawdown. You go back and check the algorithms metrics and you see over the last 7 years the max duration drawdownis thirteen months. Can you stick with this system for thirteen months underwater? Probably not.

Or, once the system gets to a 15% drawdown, well within the metrics of the system, you bail. Jack D. Schwager, author of Market Wizards, says most will bail once they hit 10%. While it is easy to look at the overall return of the system and agree that it was profitable, it is naive to think that it would not be a challenge to stick to the system at its low point.

You need to take these numbers into account when deciding on a mechanical system. Well, actually you need to take these numbers into account when trading any system.

Know the Metrics that are Important

If you find a trading system that is profitable, you need to trade it long term, or at least as long as its longer drawdown. I have not found a service anywhere that will give you the Max Drawdown duration, except QiT, of course, but it is a very important number to know.

While this can be challenging, you must find a way to stick to the plan, even if it seems boring or not worth your time in the beginning. In my opinion, trading should be boring if you are going to succeed.

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Great article! As I was reading it, I felt the crosshairs right on my forehead, having committed most of the sins you describe! I have long been a student of Larry Conners, his methods and research, I definitely believe in the system, but have often let my “trader” persona take ...

Subscribing to QiT allows me to save money and time by not having to pay for a datafeed, a trading platform, etc, and not spend hours running the stock screens, managing the datafeed, managing the trade signals, etc. Instead, all I do with QiT is check the signals each evening ...

I joined this service because I love the process of Quant trading, removes all of the emotions. Many days I when I was traveling, I couldn't even tell you where the markets closed, but just entered my signals per the system and watched my account grow.

Jason B

Thank you so much for Quantitrader and here is to many years of success. I have never been happier with any of the other services/systems I have tested over the years.

Trader Janie, I want to tell you how much that I am coming to admire you Your willingness to listen to our concerns and your new and repeated explanations to our concerns as well as your attempts at tweaking what you have already spent so much of your life ...

Let me share with you two different perpectives of the QT system of algo trading.In 1978, I joined a large Wall Street firm as a retail broker. In the following 13 years as a broker and as a Principal, I saw several things that kept most brokerage clients from making ...

Trader Janie, your system looks terrific and thanks for posting all the histories in so much detail - most systems don't do that.

Mark M

I know that drawdowns are inevitable. In the past, this made me lose money by hopping from system A to system B to system C etc. Losing and losing and losing. Always leaving right before the winning periods got in :-) That is why I like Quantitrader. I will stay ...

Shari

I, for one, sincerely appreciate all your efforts and the QiT system itself, and I'm looking forward to really seeing how it will work for me.

Don

Thanks for the new ETF Portfolio. I find it meets my trading style, and I can go short inside my IRA.

Your services pay for themselves. I have belonged to many trading services and trading rooms and I find you and your services to be the most honorable and compassionate to the little guy.Keep up the good work,

I love your service and will going live very soon. Only third day on trial here.

Jason

Today has been an awesome day across the board for me. I am at a new equity high on L2-RP, no losses on L3 ETF (to be honest only a handful of trades so far) and close to break even on L3 Ultra. I started trading the ultra signals ...

Keith

Hi Jane,I just wanted to let you know I really appreciate the trade detail you post on the website. I like seeing the trade history of the past 30 days showing the entry and exit price. I compare this to my exit price just to make sure we are tracking ...

Jane, just made all-time equity highs in my IRA thanks to Quantitrader, way to go!

Marge

It took me only 5 minutes to put my trades onto IB tonight Thanks Jane- so easy and quick. You have lots of TIME putting on the trades. There is no stress and no decisions you have to make!! Easy Peesy!!

Roger

My background with Connors and Amibroker gave me greater appreciation for all the work you have put into getting the trading results that attracted me to QiT. I thank you for your efforts and look forward to continuing.

Bob

I simply wanted to thank you for adding the Conservative play into QiT. I also appreciate adding the layer of clarity by identifying what each level means on the Signal sheet. Keep up the great work to continue improving QiT.